Roy Niederhoffer hedge fund hit in March

Firm’s largest hedge fund off 10%, but manager sees bounce

By

AlistairBarr

SAN FRANCISCO (MarketWatch) — Roy Niederhoffer’s largest hedge fund lost 10% last month because of market volatility after the March 11 earthquake in Japan.

The $368 million Diversified Program run by his firm, R.G. Niederhoffer Capital Management, was down 9.8% in March, following a 1.4% loss in February, according to an April 5 letter to investors that was obtained by MarketWatch on Thursday.

“We have had periods like this before in which exogenous negative or positive events have caught our strategy positioned incorrectly both during the event and afterwards,” Niederhoffer, brother of statistical-arbitrage pioneer Victor Niederhoffer, wrote in the letter.

“March was particularly disappointing however, given our strong start to the month,” he added. “Unfortunately, the events at the Fukushima reactor in the two days following the tsunami and the subsequent three week ‘risk-on’ rally that followed caused many parts of our strategy to incur significant losses.”

‘Risk-on’ trade

“Risk-on, risk-off” trading has dominated markets in recent years, as the financial crisis and massive government bailouts caused seemingly unrelated securities to move together. That’s up-ended some hedge fund strategies. Read about this trend here.

Niederhoffer said the buy-the-dip “risk-on” trade is the only one that’s currently working in the hedge fund industry. That’s left most managers' returns highly correlated with the equity market.

This pattern was seen when the Standard & Poor’s 500 index fell in late February and into early March, he added.

“Luckily for investors, the S&P was dutifully resilient and rebounded strongly right off the March 16 low,” Niederhoffer wrote. “However, a more sustained correction would have caused enormous losses for hedge fund investors.”

The firm’s models “incorrectly predicted this correction, and would have been quite heroic in their performance had it occurred,” the manager added.

CTA trouble

R.G. Niederhoffer Capital is a commodity trading advisor. These types of hedge fund firms, known as CTAs, use computer models to latch onto market trends.

Some CTAs were particularly exposed to equities when the Japan disaster struck. Some others were hit by the surge in the yen in the days after the catastrophe.

Longer-term trend-following managers had “loaded up” on equities, so they suffered losses when the market fell, he explained.

“In currencies, some trading systems saw the trend in the yen as broken when the yen surged and saw losses there as well,” he added.

Man Group’s (EMG) AHL Diversified Futures fund, a big CTA, lost almost 5% between March 1 and March 28, according to regulatory filings.

Three-day event

Roy Niederhoffer is known more as a short-term trader, but that didn’t help him avoid big losses in March.

The manager blamed the losses on sharp “V-shaped” moves in almost all the markets in which the firm trades, including equities, fixed-income and currencies.

What really caused problems was how long the Japan event lasted in market terms, he explained in the April 5 letter.

Most big disasters, like the Sept. 11, 2001 terrorist attacks and the Kobe quake in 1995, happen over one trading day.

This time, the first day was dominated by news of the earthquake and tsunami, but then two days followed “in which troubles at the nuclear reactor at Fukushima dominated news and extended the sell-off,” he wrote.

In the next two weeks, equity markets rebounded sharply and fixed-income “plummeted” as reports surfaced that the nuclear crisis was “somewhat” contained, he added.

These moves meant that Niederhoffer’s hedge funds failed to profit from short-term “mean reversion” trades, which focus on one to five-day periods, Niederhoffer said.

Mean reversion strategies focus on securities that move out of historical ranges, making them more likely to bounce back.

Yen trade

The Japanese yen surged against the U.S. dollar in the first few days after the March 11 quake. Niederhoffer said his firm’s long positions were stopped out just before the yen began a big drop against the U.S. currency.

“On the 18th and 19th, a large contrarian short USD/JPY position was stopped out in the other direction as the USD surged upwards,” Niederhoffer wrote.

The three-day nature of the Japan event makes it “extremely unlikely to repeat in the future,” which suggests R.G. Niederhoffer Capital’s trading systems are still effective, the hedge fund manager added.

However, he said the firm is taking “a hard look” at its risk-management to see if it could have done better at limiting losses.

Victor

Roy Niederhoffer has been running his strategy for more than 18 years. In that time, the firm has suffered losses similar to its recent performance, he noted.

In 2010, R.G. Niederhoffer’s main hedge fund lost 7% and it was down 16% in 2009. That followed gains of 51% in 2008 and 30% in 2007, when the global financial crisis raged.

“As one of the largest investors in our programs, I remain very confident in our strategy and our prospects,” he wrote in the April 5 letter.

Niederhoffer’s older brother Victor was a partner at Soros Fund Management and he ran his own top-performing hedge fund firm. Victor Niederhoffer, winner of the 1975 U.S. open squash championship, is considered one of the pioneers of statistical arbitrage, a trading strategy that tries to identify market patterns and deviations from such trends.

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